What next after FOMC and Trump?
Paid subscriber analysis
We have an election winner, and we have the FOMC decision. Both of which were anticipated by the markets. The Trump trade was being priced in by the bond market weeks in advance, and he was also leading consistently in the betting markets (it was close in the polls, but the betting markets signaled a consistent 60:40 advantage). Same for the FOMC decision; a 25bps cut was a >99% probability event, as we have said the week before.
Markets rallied 2.5% on the day after election day, as we implied they would. We made this point several times over the past few weeks: that event hedging is strong and that a rally is likely to follow after the event. From last week’s newsletter:
“Remember, vol is expensive coming into the event, and as the event passes, there is likely to be an unclench of volatility, which can often result in a strong post-event rally (VIX down, SPX up).”
But markets didn’t stop there. The rally continued on both Thursday and Friday, delivering a 5% gain for the S&P500 and 6% for the NASDAQ over the past week. Driven by the tech stocks (TSLA huge gains; this was the Musk trade), and bank stocks.
In an unwinding of the Trump trade, bonds first sold off on Wednesday, and then climbed back after FOMC on Thu and Fri to finish the week flat. USD went up, gold sold off, oil sold off. European equities sold off (Germany in particular, and its auto industry). Obviously this was just the immediate effect, but the Red Sweep scenario (still not done for the House, but looking like a Red Sweep) played out pretty much as we said in our playbook:
Here’s the summary once again:
If Trump wins, the coattail effect is likely to push Reps down the ballot to make crucial victories. This would allow the Trump administration to cut taxes heavily, restrict immigration, and introduce tariffs on foreign imports, thus making foreign goods more expensive. The consensus is that this leads to higher inflation pressures but also higher nominal GDP growth. This is bad news for bonds, and a decent scenario for equities which should rally strongly into year end and continue into 2025.
What will the Fed do? Probably reduce the number of cuts in 2025, and would outline a more hawkish SEP in December. This would have an initial negative impact on markets, but would not be sustained.
In terms of foreign policy, bearish on Ukraine, bullish on Israel, bearish on Taiwan (and the semiconductors).
We are still sticking to the same view. The crucial element here is the Fed and its reaction function.
A Trump administration that goes hard on tariffs and deportations might cause inflationary pressures to resurface. A labor market shortage in case of mass deportations would imply pressure on nominal wages, while tariffs render a direct impact on higher prices of foreign goods. Inflation won’t jump up, but if it remains elevated, the Fed might reconsider the cutting cycle and pause or at least limit the scope of cuts. This would be a potential headwind for equities.
Another risk is any potential Trump administration interference with Fed independence. Powell’s presser on Thursday was mostly boring, but it had one great moment: he was asked if he is concerned about Trump firing him, to which the answer was a simple and curt: No.
I doubt that Trump will do this. Recall that his main KPI is the S&P500. Anything that delivers great uncertainty, like messing with central bank independence, is bad news for markets. He won’t go there.
In fact, for the time being, the Trump victory released a new wave of animal spirits in the market. Earnings expectations, driven by anticipated tax cuts and deregulation, got revised upwards by 7% to 10%. This is an enormous tailwind for equities.